1-How does an actual system differ from a normal costing systems? What advantages does a normal costing systems offer?
2-Why is it necessary for a company to specify a relevant range of activity when making assumptions about cost behavior?
3- Why is it more important to have legally binding cost accounting standards for defense contractors than it is for other entities?
1- An actual costing system differs from a normal costing system in the way they calculate the cost of production.
In an actual costing system, the actual costs incurred for each specific job or production unit are tracked and assigned to that particular job. This means that the costs recorded are the exact costs incurred, including direct materials, direct labor, and overhead. Actual costing systems provide a precise and accurate measure of the cost of production for each individual job.
On the other hand, a normal costing system uses predetermined overhead rates based on estimated costs rather than actual costs. This means that overhead costs are allocated based on an estimated rate, often calculated as a predetermined percentage of direct labor costs or machine hours. Normal costing is considered to be a more practical and cost-effective approach, as it eliminates the need to track every individual cost for each job. Instead, it provides a reasonable estimate of costs while still maintaining accuracy in cost allocation.
The advantages of a normal costing system include:
1. Simplicity: Normal costing reduces the complexity and administrative burden of tracking actual costs for each job. It simplifies the cost allocation process.
2. Timeliness: Since actual costs are not tracked individually, a normal costing system allows for faster and more efficient costing. This enables the management to make timely decisions based on cost information.
3. Cost control: Normal costing allows for better cost control as predetermined overhead rates are generally based on historical data and experience. This helps in planning and budgeting activities.
2- It is necessary for a company to specify a relevant range of activity when making assumptions about cost behavior because costs are not fixed throughout all levels of activity. The relevant range is the range of activity levels over which the assumed cost relationship is expected to hold true.
Cost behavior refers to how costs change in response to changes in activity levels. Costs can be classified as either fixed, variable, or mixed. Fixed costs remain constant within the relevant range, while variable costs vary directly with changes in activity levels. Mixed costs have both fixed and variable components.
Specifying a relevant range is important because cost behavior assumptions made within that range might not hold true outside of it. For example, if a company assumes that the cost of producing 1,000 units of a product is $10,000, it does not mean that producing 2,000 units will cost $20,000. The cost behavior assumption may not hold true beyond the specified relevant range.
By specifying a relevant range of activity, a company can make more accurate cost projections and plan its operations accordingly. This helps in budgeting, pricing decisions, and overall cost management.
3- Legally binding cost accounting standards are more important for defense contractors compared to other entities due to the nature of their business and the significant involvement of government contracts.
Defense contractors often work on large government contracts, which involve substantial amounts of taxpayer dollars. The government and taxpayers need assurance that these contracts are executed efficiently, transparently, and within reasonable costs. This is where cost accounting standards come into play.
By implementing legally binding cost accounting standards, defense contractors are required to accurately track and report costs related to government contracts. These standards help ensure that costs are allocated correctly and that proper controls are in place to prevent fraud, waste, and abuse of taxpayer funds.
Furthermore, defense contracts are subject to intense scrutiny, audits, and oversight from government agencies such as the Defense Contract Audit Agency (DCAA). Legally binding cost accounting standards provide a framework for consistency and compliance with regulatory requirements.
In contrast, other entities may not have the same level of government involvement or reliance on taxpayer funds. While cost accounting standards are still important for other entities to ensure accurate financial reporting, legal enforcement may not be as crucial as it is for defense contractors.